Gone Are The Days When The U.S. Bond Market Was The Place To Be

Michael Lombardi: In 1980, the total outstanding debt in the U.S. bond market was about $2.5 trillion—this included municipal bonds, Treasury bonds, money market instruments, corporate debt, and asset-backed securities. Fast-forward to 2012, and the U.S. bond market stands

at $38.13 trillion—an increase of more than 1,400%! (Source: Securities Industry and Financial Markets Association, March 7, 2013.)

The chart below shows how the U.S. bond market has ballooned over time.

As I have written in these pages before, I expect the coming sell-off in the U.S. bond market to start slowly; nothing like what we saw when the key stock indices plummeted in 2008 and 2009. It will be slow and steady, gradually picking up speed.

Bond investors are facing two risks in the U.S. bond market: interest rate risk and credit risk.

The Federal Reserve has been keeping interest rates artificially low since the financial crisis began, while printing an unprecedented amount of new paper money in its efforts to boost economic growth. The Fed will eventually have to raise interest rates to tame inflationary pressures. When that happens, bond investors could face extensive losses. A simple rule of economics: bond prices fall when interest rates rise. The U.S. bond market will be no different.

The U.S. government is spending with two hands. It has been posting budget deficits of more than $1.0 trillion for the last four years. It won’t surprise me to see another year with a U.S. budget deficit of more than $1.0 trillion. The U.S. national debt is headed well above $17.0 trillion.

Dear reader, it is not a hidden fact anymore: the U.S. government is spending rigorously, while borrowing from the Federal Reserve to stay afloat. Unfortunately, this type of behavior can only go on for so long before our creditors—the bond investors—realize the Ponzi scheme that’s really happening.

As a result of all this, there is already softening in the U.S. bond market. For example, 30-year U.S. bond prices have been declining since November of 2012, having fallen more than 4.5%.

The glory of the U.S. bond market may just be coming to an end. A hike in interest rates is not that far off now. Gone are the days when the U.S. bond market was the place to be.